Investors Still Doing Early-Stage Deals
by Lee Condon

3/19/01

For months, venture capitalists have been saying they are avoiding new investments and instead focusing on companies already in their portfolios.

But a recent report by the Los Angeles Regional Technology Alliance indicates that VCs are not backing away from making early-stage or seed investments in Los Angeles startups.

LARTA reported that seed and first-stage investments grew by more than $50 million from the second to the third quarters of 2000. In addition, 30 percent of all investments in the third quarter were seed or first-round investments. Under LARTA’s definition, a seed or early-stage investment can include anything from the very first VC investment made in a company all the way up to a fourth round of funding.

Rohit K. Shukla, CEO of LARTA, said the activity shows that VCs are still interested in startups and in expanding their local portfolios.

“What we’re seeing is a continued emphasis on early-stage investments,” Shukla said. “It was significantly large to be interesting for our report.”

One tangible shift has been that VCs locally have been shying away from pure-play Internet and e-commerce businesses, and Shukla was not able to cite any examples of VCs making a substantial investment in any brand new companies in late 2000. However, he cited several major deals as examples of how early-stage investment has continued in Los Angeles, including:

• $50 million for Monrovia-based Xencor, a biotech company that is developing more effective proteins for use in pharmaceuticals and other products;

• $50 million for XDrive, a Santa Monica-based infrastructure software and services company;

• $68 million for Creative Planet in cumulative deals from August through December;

• A total of $78 million for Cyoptics from April through October;

• $25 million for Estyle, an e-commerce business specializing in clothing and fashion;

• $60 million for Econnections, which provides global supply chain management for the electronics industry.

The findings of the LARTA report was not a surprise to Dave Lavinsky, president of L.A.-based Growthink Inc., which specializes in assisting growing companies.

Lavinsky said that some VCs are concentrating on their current portfolios while others are being very aggressive about finding new investments.

“They are still always seeking that next best thing,” Lavinsky said. “The IPO market is not doing well, but that’s going to change. Now is a good time to find angel deals.”

He noted that last year there were more VC investments than in the previous 15 years combined.

“It has fallen from an unbelievable peak. But this year will be as big as 1999. It will still be a huge sum of money,” Lavinsky said.

Jay Humphlett, a senior associate with Santa Monica-based Palomar Ventures, said his company is still heavily in the market looking for new deals, while others have shied away from startups.

“Some of the venture firms were heavily weighted into pure-play Internet deals,” Humphlett said. “Those firms are spending a lot of their time doing triage now.”

But Palomar never made Internet companies a key part of its portfolio. Only three of its 17 deals have involved pure-play Internet companies. Palomar is able to keep investing because it has focused on Series A funding for technology infrastructure companies. In the last four months, Palomar invested in Innovics, a Santa Monica-based company in the wireless semiconductor space, and Umachines, a Pasadena-based company focused on optical switching.

New deals, maintenance

Frank Creer, managing director of Zone Ventures, a downtown VC firm, said his group has not slowed in terms of investing in startups. Zone focuses its efforts exclusively on early-stage investments.

Creer said the environment is better now for VC investing because startups are working harder to make their companies attractive for investment.

“You’ve weeded out all the entrepreneurs who were just in it to make a quick buck. All the people in it now know their chance of going public is low,” Creer said.

Trident Capital’s Todd Springer said his company, like many VCs, has pulled back from investing in startups in order to spend time working with companies already in its portfolio.

“We have placed a priority on our existing investments,” Springer said.

The company is still looking for new companies to invest in, but will be quite picky about its selections.

“We’ll only look at early-stage companies with experienced management teams,” Springer said. “I don’t think it’s a matter of changing strategy.”

Humphlett acknowledged that this is a “strange time” in the market, but the strongest and smartest VCs will stay active in making new investments.

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